In this series we’ve already talked about budgeting, succession planning, and building your Green Box. Today, I’d like to talk about Growth - not just revenue growth, but determining the right kind of revenue and leveraging that knowledge to build growth and long term value for the business.
A few months back, we had my good friend David Wible, a member of the 17% Club, on our podcast, and he offered a slice of wisdom that should not be overlooked by any business owner. David went through a process in his business to determine exactly what his Value Creation Revenue or VCR was - and then relentlessly grew that revenue in his business - building amazing value and ultimately exiting that business based on the value he created.
For his business - the VCR was recurring revenue. Ironically, that also turned out to be the magic bullet for my last business - a business, by the way, that no one believed could deploy a recurring revenue model. In 2004, we hunkered down and found a way to do it, and it changed our industry forever. In fact, today recurring revenue is the prevalent sales model in that industry.
Recurring Revenue VCR
So, for any of you nay-sayers that think you’re in an industry that can’t be converted to recurring revenue - let me tell you a little story…
I bought a little restaurant technology company in 2001. When I bought the business, they were doing a measly 4% of their half-million dollars in annual revenue as recurring revenue. That 4% was almost entirely for help desk support for our software. Let me put this into perspective for you. We had 4 people working full time, 24 hours a day, taking support calls from our customers. 4% of $500K in revenue is $20,000 a year. That revenue didn’t even pay for one support engineer, let alone 4 of them. Now, mind you, the business had a history of supporting any customer who had our product, whether or not they had a support agreement in place. If they did not, we would just bill them for the time and hope they would pay it. The day I bought the business, we wrote off over $300K in bad debt for unpaid support calls. Something had to change.
Within a month of buying the business, we launched a campaign to get our customers on a support agreement. We offered annual and monthly plans, but gave incentives to go with the monthly support plan. In addition, we informed our customers that we would no longer accept after-hour calls from customers who did not have an agreement in place, and then we changed the way we took non-agreement customer support calls. Rather than billing them for the time to resolve the issue, we started charging a $250 flat fee per call. Despite the grumbling from our customers, most of them paid for the support call, and afterward, we offered to credit that back if they decided to get on a support plan within 30 days.
Did you get pushback? You bet we did! Those customers who were used to calling, and then getting a $25 invoice that they would never pay screamed the loudest! But we held our ground and in less than 3 months, we had nearly 40% of our customers on a long term support agreement - and the support department started paying for itself.
That little exercise only whet my appetite for recurring revenue.
Next, I started looking for other ways to build recurring revenue because I knew that recurring revenue was one of the biggest drivers of business value. Why? Because recurring revenue is predictable - and virtually guarantees a buyer that the revenue will be sustainable long into the future. (That’s an over-generalized statement because there are best practices when it comes to building recurring revenue - but for now, take it at face value.)
So, slowly, one by one, we started adding additional products or services that would be charged on a monthly recurring basis. Over the next few years, we added online ordering, merchant services, loyalty programs and other recurring services - but our core business was still selling hardware and software up front, and then hoping to add the additional services on the back end.
I knew I could convert software to a monthly SaaS (or software as a service) model, but struggled to find a way to do the same thing with the hardware. It was just too expensive to deploy without getting it paid for upfront. When I finally set my mind to doing it, it took me months to develop a formula that made sense. One that balanced the risk and reward for the business. But ultimately - we had our breakthrough moment - and never looked back.
Our breakthrough was to find ways to partner with our suppliers to extend payment terms on the hardware to match the terms we had given to our customers. That way, we were able to reduce our cash outlay at the beginning of the agreement with our customers, and achieve cash flow faster than if we had paid for the hardware upfront.
Now mind you - converting to a recurring revenue model is going to impact your cash flow and profitability initially, so it’s important to develop a model that ensures that you won’t run out of cash before the recurring revenue can contribute to cash flow. But once it does, it’s like Warren Buffett describes compounding interest.
“Compound interest is an investor's best friend. Building wealth through interest is like rolling a snowball down a hill. Start early.”
– Warren Buffett
Well it’s the same principle with recurring revenue, which compounds over time and can exponentially increase the value of your business.
Again, let me caution you that you need to run your models so you’ll know exactly when you’ll cross the cash flow and profitability targets - and to ensure that you won’t run out of cash quickly. Running out of cash is a small business disaster!
No Way to Build Recurring Revenue - Think Again!
Let’s address those businesses that claim to have “no way” to build recurring revenue. For example, a distribution company. A wonderful alternative to recurring revenue is long term contracts with your customers. Long term contracts can be your VCR or Value Creation Revenue. Having long term contracts, like recurring revenue, guarantees future buyers that your revenue is “sticky” and will be predictable into the future.
In fact, long before I was able to crack the recurring revenue code, it was the long term contracts with my distribution customers that gave me the inspiration for recurring revenue. In the 1980s and 90s, I was in a distribution business selling radiology to hospitals and doctors offices. Over time, we were able to secure long term distribution agreements with our customers that provided “just in time” delivery and guaranteed best pricing for them, and long term revenue for us. Let’s face it, if you can secure $1M a month in revenue, even at the razor thin margins of distributors, then it becomes a matter of managing expenses and cash flow. It was the lessons I learned from these experiences that taught me the value of cash flow management, and later inspired me to convert my future businesses to recurring revenue.
So, let’s recap. As you build your business - figure out what your Value Creation Revenue is. Perhaps it’s creatively developing a recurring revenue model, or maybe it’s finding ways to secure long term agreements with your customers. Whatever it is, find ways to build that Value Creation Revenue that will guarantee the future revenue of your business. Having that long term, predictable revenue stream will dramatically improve the long term value of your business.
Call to Action:
Go work on it today! And, if you're stuck, or don’t know where to start - just go to our website (masterypartners.com) and click the link to schedule a free consultation with me. I promise, you won’t be disappointed!
If you need any help, just go to our website and click the button to schedule a call with me. And remember, we’re here to help. If we can help you in any way don’t hesitate to reach out!
Before we sign off this week - I want to let you know that for the first time in 90 weeks - we’re taking next week off from our podcast and blog, but I can’t wait to share all of the amazing things we have in store for you in 2022.
ABOUT THE AUTHOR
Tom Bronson is the founder and President of Mastery Partners, a company that helps business owners maximize business value, design exit strategy, and transition their business on their terms. Mastery utilizes proven techniques and strategies that dramatically improve business value that was developed during Tom’s career 100 business transactions as either a business buyer or seller. As a business owner himself, he has been in your situation a hundred times, and he knows what it takes to craft the right strategy. Bronson is passionate about helping business owners and has the experience to do it. Want to chat more or think Tom can help you? Reach out at tom@masterypartners.com or check out his book, Maximize Business Value, Begin with The Exit in Mind (2020).
Mastery Partners, where our mission is to equip business owners to Maximize Business Value so they can transition their business on their terms. Our mission was born from the lessons we’ve learned from over 100 business transactions, which fuels our desire to share our experiences and wisdom so you can succeed.